Professional Documents
Culture Documents
The information provided in this document is intended solely for you. Please do not freely distribute.
2
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
200.2. Jane writes an out-of-the-money (OTM) call option with a one-year term and a strike
price of $30.00 when the current trading price of the underlying, non-dividend-paying stock is
$26.00. The volatility of the stock is 46.0% per annum and the risk-free rate is 4.0%. There are
250 trading days in the year. If Jane assumes stock returns are i.i.d. normal and short-term drift
(mu) rounds to zero, which is nearest to the ten- (10-) day, 95.0% delta-normal value at risk
(VaR) of the short call option position?
a) $0.33
b) $1.97
c) $3.68
d) $5.12
200.3. Joe has a long position in a 10-year zero coupon bond with a face value of $100 and a
yield (YTM) of 8.0% with annual compounding. The daily yield volatility is 30 basis points and,
for convenience, Joe assumes the daily yield is normally distributed. Joe is only interested in a
linear (duration-based) value at risk (VaR). Which is nearest to the one-day 99.0% linear VaR
of the bond position?
a) $1.40
b) $2.12
c) $3.00
d) $3.24
3
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
Answers:
200.1. A. Implies a one-day 95% VaR of $5.1 million = $16.1 / SQRT(5) * (1.645/2.33) ~=
$5.1 million
But each of (B), (C) and (D) scales up from a one-day 95% VaR of $4.0 million:
(B): $17.9 / SQRT(10) * (1.645/2.33) ~= $4.0 million,
(C): $17.9 / SQRT(20) ~= $4.0 million, and
(D): $25.3 / SQRT(20) * (1.645/2.33) ~= $4.0 million.
200.2. B. $1.97
Option delta = N(d1) and d1 = [ln(S/K) + (r + sigma^2/2)*T]/[sigma*SQRT(T)]. In this case,
d1 = [ln(26/30) + (4% + 46%^2/2)*1]/[46%*SQRT(1)] = 0.0027/46% = 0.006 which is close to
zero such that d1 ~=0 and N(d1) = ~0.50
10-day, 95% delta-normal VaR (short option) = ABS(delta) * Price[Stock] * Volatility[annual] *
SQRT(10/250) * deviate. In this case,
10-day, 95% VaR = 0.5 * $26.00 * 46.0% * SQRT(10/250) * 1.645 = $1.97
Please note:
i.i.d. is assumption that is necessary to scaling the annual volatility down to 10-days with
SQRT(10/250)
This underestimates the VaR, from the perspective of the short position, by omitting
gamma
A typical exam question almost certainly would give you delta, N(d1), we just wanted to
"sneak in" an extra step for you to practice N(d1).
200.3. C. $3.00
The bond's modified duration = Mac duration/(1+yield/k) where k is compound periods per year
= 10/1.08 = 9.26 years.
The bond price = 100/1.08^10 = $46.32.
The 99% VaR = $46.32 * (0.0030 * 9.26 * 2.33) =$3.00
4
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
a) $600.00
b) $643.36
c) $838.80
d) $1,398.00
201.2. Jane has a short position in 100 put option contracts (10,000 options) where, according
to Black-Scholes Merton, N(d1) = 0.650 and the per option (percentage) gamma is 0.0150. The
one-day 95.0% value at risk (VaR) on a single share of the underlying non-dividend-paying
stock is $4.00. Assuming i.i.d. returns, what is the 10-day 95% VaR of the short put option
contract?
a) $25,880
b) $44,300
c) $56,272
d) $91,667
201.3. Bond has a long position in a bond with a face value of $1,000.00. He assumes the daily
yield volatility is 1.0% with normally distributed daily yields. The bond's modified duration is 9.70
years and its convexity (C) is 100.0 years^2. The current price of the bond is $612.00. What is
the 95% daily (quadratic) value-at-risk?
a) $89.37
b) $97.65
c) $152.30
d) $206.59
5
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
Answers:
201.1. B. $643.36
10-day 99.0% VaR of the contract = $100*30%*SQRT(10/250)*2.33 = $13.98.
Per Taylor Series approximation, quadratic VaR(per call option) = 0.6 delta * $13.98 - 0.5 * 0.02
gamma * $13.98^2 = $6.4336
... did you remember to SUBTRACT the gamma term due to the long call position? How can
that be, since the Taylor Series is a summation? VaR is the downside risk, so we are using a
negative shock to the stock price: change in long option = -S*delta + 0.5*gamma*S^2 =
estimated loss, but we are expressing VaR as a positive, so mathematically we have:
-[-dS*delta + 0.5*gamma*dS^2] = +dS*delta -0.5*gamma*dS^2.
100 options * $6.4336 = $643.36
201.2. C. $56,272
The 10-day VaR = SQRT(10)*$4.00 = $12.65; scale per square root rule if returns are i.i.d.
The delta of the put option = 1 - N(d1) = 1 - 0.65 = -0.35;
note: the percentage delta of a put is between [-1,0]
The short put is riskier on the downside due to the gamma (curvature). Mathematically:
As dc ~= delta*dS + 0.5*gamma*dS^2, as the downside risk in a short put occurs when the
stock price decreases, we have:
dc ~= -delta*-dS + 0.5*gamma*-dS^2 = +delta*dS + 0.5*gamma*dS^2; i.e., the gamma terms
adds (increases the risk)
201.3. A. $89.37
VaR = abs[-duration*price]*VaR(yield) - 0.5*convexity*price*VaR(yield); i.e., the downside risk is
an increase in yield, which the convexity mitigates.
As VaR(yield) = 1.0% * 1.645 = 1.645%,
VaR = 612*[9.70 years*1.645% - 0.5*100*1.645%^2] = $89.373
6
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
a) $17.25
b) $33.18
c) $47.00
d) $66.51
202.2. Bob tries to value a three month European put option with a one-step binomial tree (one
step = 0.25 years). The price of the non-dividend-paying stock is $100.00 and the put option is
at-the-money (ATM) with a strike price of $100.00. The asset volatility is 36.0% per annum with
continuous compounding. The riskless rate is 4.0%. Bob decides that volatility will inform the
size of the up (u) and down (d) steps according to a Cox, Ross Rubinstein (CRR) model; i.e., if
the number of steps were increases the asset price would tend toward a lognormal distribution.
a) $2.89
b) $8.43
c) $15.05
d) $20.76
202.3. Risk Manager Mark is pricing a six-month American put option on a non-dividend-paying
stock when the stock price is $105.00. The put option is out of the money (OTM) as the strike
price is $100.00. Mark assumes a two-step tree such that each step is three months. He
assumes a 6.0% riskless rate with continuous compounding. Instead of "matching volatility with
up (u) and down (d) size movements," Mark simply assumes the size of the up movement is
+20% and the size of the down movement is -20%; i.e., u = 1.20 and d = 0.80. What is nearest
to the estimate of the price of the American put option? (variation on GARP 2012 Sample
Questions 7 and 8)
a) $5.34
b) $6.80
c) $7.29
d) $8.51
7
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
Answers:
202.1. D. $66.51
The worst outcome occurs at node [date 8, state 0] where the asset has dropped at each node;
this occurs with probability (1 - 44.0%)^8 ~= 0.97%
The absolute 99.0% VaR is therefore the loss implied by the next node up at [date 8, state1]
which is given by $100*d^7*u^1 = $100*(1/1.2)^7*1.2 = $33.49.
Note 1: A relative VaR would compute E[asset price] - $33.49, but an absolute VaR
subtracts from the initial value and consequently "incorporates" the drift:
Because drift = E[asset price] - 100, and absolute VaR = -drift + (E[asset price] - 33.49)
Absolute VaR = (100 - E[asset price]) + (E[asset price] - 33.49) = 100 - 33.49;
ie, don't need the future mean.
Note 2: the real-world probability (p*) is appropriate because this is not (discounted PV)
option valuation, this is rather an inference about a future real-world distribution
Note 3: As the distribution is discrete, $66.51 is NOT the only acceptable answer. The
two worst outcomes are: $23.26 with p = 0.97% and $33.49 p = 6.1%. An interpolation
would be acceptable for a slightly different answer; although the 0.97% outcome was
deliberately calibrated to be near 1.0% such that the "next worse" outcomes makes
logical sense under simple historical simulation approaches.
8
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
202.2. B. $8.43
The down movement is to $100*exp[-36%*SQRT(0.25)] = $83.5270,
with future put option value of max[0, 100-83.5270] = $16.4730.
202.3. C. $7.29
9
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
a) $78.21
b) $85.25
c) $88.89
d) $89.02
203.2. A one-year ATM European call option has a strike price equal to the stock price of
$40.00 while the riskless rate is 4.0% and the stock pays no dividends. If the risk-neutral
probability that the option will be exercised (i.e., expire in the money) is 46.0% and the price of
the call is $7.03, what is the option's delta?
a) -0.38
b) 0.50
c) 0.53
d) 0.62
203.3. A one-year European put option with a strike price of $50.00 is out-of-the-money as the
price of the underlying non-dividend-paying stock is $56.00. The price of the put = $3.180 =
$50.00*exp(-3%*1)*0.3715 - $56.00*0.2651. Each of the following must be true EXCEPT:
10
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
Answers:
203.1. B. $85.25
c = S*exp(-qT)*N(d1) - K*exp(-rT)*N(d2), where (q) = dividend yield. In this case,
c = exp(-2%*0.25)*$1400*0.54 - $1400*exp(-3%*0.25)*0.48 = $85.25058.
In regard the other answers: (A) is price of a put; (C) is price with one-year term,
and (D) is price with no dividend.
203.2. D. 0.62
c = S*N(d1) - K*exp(-rT)*N(d2), where N(d2) is the risk-neutral probability of exercise and N(d1)
is the call option delta. Therefore,
N(d1) = [c + K*exp(-rT)*N(d2)]/S = [$7.03 + $40*exp(-4%*1)*0.46]/40 = 0.6177
203.3. C. False. Per put-call parity, the call = 56 + $3.180 - 50*exp(-3%) = $10.66
11
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
a) Buy (long) 180 call options and sell (short) 148 shares
b) Sell (short) 180 call options and buy (long) 148 shares
c) Buy (long) 90 call options and sell (short) 52 shares
d) Sell (short) 90 call options and buy (long) 52 shares
204.2. Portfolio Manager Sally has a position in 100 option contracts with the following position
Greeks: theta = +25,000, vega = +330,000 and gamma = -200; i.e., positive theta, positive vega
and negative gamma. Which of the following additional trades, utilizing generally at-the-money
(ATM) options, will neutralize (hedge) the portfolio with respect to theta, vega and gamma?
12
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
Answers:
204.1. A. Buy (long) 180 call options and sell (short) 148 shares
The short puts have a position delta = -100 * -0.40 = 40; and a position gamma = -100 * 0.09 = -
9.0.
Since the call options have per option gamma of 0.05, 9.0/0.05 = long 180 call options will
neutralize gamma.
But long 180 call options with per option delta of 0.60 adds 180 * 0.60 = 108 position delta, for a
total position delta of 40 + 108 = 148
Therefore, North Dealer must short 148 shares to neutralize delta (shares have delta of 1.0)
To buy short-term options + sell long-term options --> negative position theta, negative position
vega, and positive position gamma.
In regard to (A), sell short-term + sell long-term --> positive theta; negative vega;
negative gamma
In regard to (B), sell short-term + buy long-term --> positive theta; positive vega; and
negative gamma.
In regard to (D), buy short-term + buy long-term --> negative theta; positive vega; and
positive gamma
Note: the above are approximately actual numbers for 100 option contracts (100 options each =
10,000 options) with the following properties: Strike = Stock = $100; volatility = 15.0%, risk-free
rate = 4.0%; term = 1.0 year. Under these assumptions
204.3. D. The reverse: position gamma decreases with maturity for a long position, but
increases (negative to negative) with maturity for a short position
13
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
a) 1.0%
b) 2.0%
c) 3.0%
d) 4.0%
205.2. A portfolio contains three bonds with, respectively, the following values and modified
durations:
$95.00 value with 2.0 years modified duration,
$108.00 value with 5.0 years modified duration, and
$143.00 value with 9.0 years modified duration
If the daily yield is normally distributed with volatility of 1.0%, which is nearest to the portfolio's
daily value at risk (VaR) at the 99.0% confidence level?
a) $46.92
b) $116.23
c) $250.41
d) $1,300.00
205.3. Robert the Fixed Income Portfolio Manager has a long position in a bond portfolio with a
face value of $1.0 million and a dollar value of an '01 (DV01) of +$0.040, per 100 face value. He
wants to duration hedge the exposure with a short position in a zero-coupon bond. The hedging
bond has a price of $69.80 and a modified duration of 9.0 years. Which is nearest to the face
value amount of the short bond position will implement the hedge?
a) $329,450
b) $636,740
c) $1,170,260
d) $1,650,850
14
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
Answers:
205.1. C. 3.0%
Under semi-annual frequency, F(3,5) = ([(1+r5/2)^10 / (1+r3/2)^6]^(1/4) - 1)*2
but since P3 = F/(1+r3/2)^6 and P5 = F/(1+r5]/2)^10,
[(1+r5/2)^10 / (1+r3/2)^6] = P3/P5, so that
F(3,5) = (P3/P5^(1/4) - 1)*2 = (97.05/91.43^0.25 - 1)*2 = 3.00498%
205.2 A. $47.00
Dollar duration of portfolio = ($95*2) + ($108*5) + (143*9) = $2,017.00
99% daily VaR = $2,017 * 1% * 2.33 = $46.92 (or $47.00)
205.3. B. $636,740
As DV01 = mod duration * Price/10,000, the DV01 of the hedging bond = 9.0*$69.80/10,000 =
$0.062820.
F(hedging bond) = -F(exposure)*DV01(exposure)/DV01(hedging bond) = -$1,000,000 * $0.040/
$0.062820 = -636,740;
i.e., short position of $636,740 in face amount will neutralize (equalize) the DV01/dollar duration
of the net position.
15
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
Given the one-year transition matrix above, which of the following statements is TRUE:
a) After two years, the cumulative probability that an AAA-rated bond will be AAA-rated is
84.60%
b) Within two years, and assuming Markovian independence, the cumulative probability
that a CCC-rated bond will default is 25.57%
c) After one year, a B-rated bond has a 76.20% probability of at least maintaining its rating;
i.e. B-rated or better
d) Within two years, an AA-rated bond cannot default
206.2. In regard to credit events, each of the following is true EXCEPT for which is false?
16
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
Answers:
206.1. B. Within two years, and assuming Markovian independence, the cumulative
probability that a CCC-rated bond will default is 25.57%
P[CCC-rated defaults within two years] = P[CCC default in one year] + P[CCC-->BBB-->D] +
P[CCC-->BB-->D] + P[CCC-->B-->D] + P[CCC-->CCC-->D]
P[CCC-rated defaults within two years] = 15.00% + 0.020% + 0.20% + 1.65% + 8.70% =
25.570%
In regard to (A), this as false as the probability is 84.70%. Difference is P[AAA-->AA--
>AAA] = 8% * 1% = 0.080%
In regard to (C), this is false as the probability a B-rated maintains = 80.0%
In regard to (D), this is false as an AA-rated can default in second year if AA migrates to
BBB or lower in first year. The probability that an AA-rated defaults within two years is
0.0330%
206.2. D. False: While a downgrade is not among the ISDA definitions (bankruptcy, failure
to pay, obligation/cross default, obligation/cross acceleration, repudiation,
restructuring), a downgrade may be a credit event.
206.3. D. S&P ratings are a measure of PD while Moody's ratings are a measure of the
joint effect of PD and LGD
In regard to (A), BB+ is the highest speculative rating
In regard to (B), Baa3 is the lowest investment grade rating
In regard to (C), higher ratings --> lower leverage ratios and higher cash flow coverage
17
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
a) $22,300
b) $84,500
c) $130,000
d) $209,320
207.2. Credit unexpected loss (UL) is a linear and increasing function of which of the following?
a) Adjusted exposure
b) Probability of default (EDF)
c) Standard deviation of default probability
d) Loss given default (LGD)
207.3. A bank's economic capital (EC) for an exposure is calibrated at four standard deviations
from the expected value of the exposure at the future horizon; i.e., EC = 4*UL, where UL is one
standard deviation. Of the original $100.0 million commitment, 20% is outstanding and the
estimated drawdown given default (UGD) is 50.0%. The probability of default (EDF) is 2.0%.
Both the loss given default (LGD) and the standard deviation of LGD are 40.0%. Which is
nearest to the exposure's economic capital?
a) $2.0 million
b) $4.8 million
c) $19.1 million
d) $59.4 million
18
Licensed to Manuel Privera at manuelprivera@mail.com. Downloaded September 28, 2016.
The information provided in this document is intended solely for you. Please do not freely distribute.
Answers:
207.1. B. $84,500
AE = $6.0 MM OS + 50%*($20.0 - $6.0 MM) = $13.0 MM.
EL = AE*PD*LGD = $13.0 MM * 1.0% * 65.0% = $84,500
19